A permanent security blanket for big boys of finance will further inflame public opinion. Only the public isn't likely to know.

December 8, 2009

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The sales pitch for financial-reform legislation pending in the House claims it would put an stop to “too big to fail” bailouts for the leading banks. The reality is the opposite. The federal government would instead be granted unlimited authority to spend whatever it takes to prop up the big boys when they get in trouble. Only in the next crisis, Congress won’t have to be asked for the money. The financial rescues will be funded by the secretive Federal Reserve, not the Treasury, with money the Fed itself creates.

And the emergency lending could be pumped into any financial institution in trouble–not just behemoth commercial banks but investment houses like Goldman Sachs, insurance companies, hedge funds or any other pools of private capital whose failure regulators believe would threaten the system.

This sounds nutty and it is. A permanent security blanket for big boys of finance could further inflame public opinion. Only the public isn’t likely to know. The crucial terms for Fed financing are set by an innocuous-sounding amendment offered by Representative Brad Miller of North Carolina. Any financial holding company designated as a “systemic risk” and subject to stricter regulatory standards “shall have the same access to the discount window lending of an appropriate Federal Reserve Bank as is available to a member bank of each Federal Reserve bank.”

This last-minute amendment, if included on final passage, solves a huge problem for the Obama administration–how to pay for the next bailout if another financial calamity unfolds. In the House banking committee, the administration’s legislation originally sought unlimited authority for the Treasury and the president. But committee members choked on the implications after Representative Brad Sherman of California denounced it as “TARP on steroids.” TARP was the original $700 billion bailout jammed through Congress last year. Citizens are still angry and some members of Congress who voted for TARP are likely to lose their seats.

Solution? Let the Fed do it behind closed doors. The Federal Reserve’s discount lending to commercial banks is normally not disclosed to the public since it might signal the bank is in trouble and undermine investor confidence. That secrecy can hardly be sustained in another crisis, however, since financial markets will swiftly figure out which financial firms are the lucky winners in the Fed’s fail-or-flourish lottery.

The so-called reform legislation has many other problems–too many to clean up at this stage in the legislative process–but somebody should start right now to raise a righteous stink about the core provisions. As I have been writing for months, putting the Federal Reserve in charge as super-regulator is the path that leads to the corporate state. A limited circle of privileged players would enjoy a permanent line of credit from Washington, while their competitors in business and finance would struggle at great disadvantage. This top-down economy would combine the worst qualities of both socialism and capitalism. Unfortunately, the hybrid nature of the monstrosity may not become clear, even to members of Congress, until the next crisis, when it will be too late.